Mizuho was proud to be a platinum sponsor of the Structured Finance Association’s SFVegas 2023 industry conference recently concluded in Las Vegas. Dubbed the “largest capital markets conference in the world”, the gathering met expectations with record attendance of more than 8,500 participants from across the structured finance industry and returned to its familiar late February spot on the calendar for the first time since 2020. Mizuho’s structured finance product team hosted clients and investors to discuss market trends, issuance strategies and the broader economic backdrop over the course of the three-day conference. Kinnary Armstrong, Executive Director on the Mizuho team, also joined a panel discussing deal activity and the outlook for the Aircraft ABS sector in 2023.
It was hard to ignore that all eyes at the conference were on the consumer, specifically how this sector will fare with continued inflationary pressures and higher interest rates in a potentially weaker economic environment. Consensus view by issuers and investors is that a potential recession will be a shallow one – less severe than the 2008-2009 financial crisis. Nevertheless, in light of the current economic uncertainty, most clients we spoke with that originate consumer debt have tightened underwriting standards somewhat over the past year with a particular focus on curbing originations of near- and non-prime exposure, focusing originations on higher fico borrowers and shortening loan tenors. While the performance of non-prime consumer assets remains within market expectations, we regard the conservativism shown by issuers to be prudent. Some ABS investors at the conference were probing near- and non- prime originators on how they are faring in light of increased cost of funds and compressing margins in an environment with limited ability to increase collateral APRs further.
Within the auto finance sector more broadly the largest and most dominant asset class in the ABS market, early 2023 origination vintages are generally exhibiting weaker performance than second half 2022 vintages. Most market metrics indicated consumer credit quality is at or near a point of inflection – matching pre-COVID loan delinquency and default levels. The return to 2019 credit quality has been fueled by a combination of factors, including lower used vehicle values that have fallen from COVID-era record peaks, higher interest rates, inflation and a drop in household cash holdings as government support becomes a distant memory. The question for 2023 is where does consumer credit quality go from here?
Despite the change in performance, investor sentiment towards auto ABS generally came across as positive, given robust credit enhancement structures and compelling all-in yields in the sector. A common theme we heard from investors was an emphasis on short dated quality paper (generally senior and fixed rate) and overall strong demand from a majority of investors for ABS across a variety of issuers and collateral types. For subordinate bonds, there appears to be generally good demand for investment grade subordinates, less so for below investment grade sub-debt and even less interest among issuers to sell residual/equity given the expected sky-high clearing rates.
Other topics we heard in meetings and hallways at the conference included:
- Geopolitical issues particularly revolving around Eastern Europe and China. Not really a major focus of most discussions given the largely muted impact on the ABS market but recognized as a broader matter to monitor.
- ESG investing is something many ABS investors still don’t have specific mandates to pursue and some large buyers question the merits from a fiduciary viewpoint. However, there are a number of issuers focusing on adding some sort of sustainability/inclusionary strategy/disclosures around their debt issuance. These standards remain to be undefined.
- Supply chain bottlenecks have improved significantly but linger as an issue among the vehicle and equipment OEMs and captives. The impact has virtually halted most floorplan ABS issuance and financing for the better part of three years now. However, there is a growing expectation that we will see floorplan ABS from a least two US captive issuers return in 2023.
- Bank financing and forward flow from private credit remain robust sources of liquidity for clients either as an alternative to ABS issuance or as a complimentary source of financing. Asset managers and PE firms are generally projecting a sense of optimism on consumer assets at this point in the cycle and have been actively deploying balance sheet. Bank balance sheets are perhaps not as open for new securitization volume as they were last year but, for the right price and structure, capacity exists.
The Way Forward
All told, the structured finance landscape as we move into 2023 appears to be solid. Consumer and commercial credit fundamentals are weathering the economic stress of a rising rate environment well and market liquidity has returned to a more normal equilibrium – the resilience of both instills confidence in the ABS market and bodes well for momentum to build as the year unfolds.
The Mizuho Securitized Products Origination team is eager to engage with our client and investor relationships in the new year!